This is the introduction by Sergio Cesaratto at the Meeting in Madrid Economy4Youth held 22-3 November 2012. Press coverage includes here, here, here, here and here, so far. The videos are here, but some better quality videos will likely be posted.
PIGS in Madrid
By Sergio Cesaratto* (Cesaratto@unisi.it)
Dear students and colleagues, ladies and gentlemen, companeros y companeras (if I am allowed to say so), I wish first of all to thank the organisers and the supporters of this event. I believe this is a beautiful opportunity to work side by side with the young people who are fighting against the present state of things and the critical economists. This is not a conference against Europe, or of one part of Europe against the other. As people of “troubled Europe” we feel perhaps more concerned than the majority of our northern fellows. But I think that the message of this meeting should arrive especially at your young northern fellows not just asking for solidarity (a word that I personally look suspiciously at), but because the dismantlement of the social rights in our countries might be the premise to the reduction in their own. I believe that they would defend the idea of their countries being part of a peaceful and prosper continent, and be outraged by the idea of their countries as islands in the midst of deprivation and resentment. I also believe that youth is the time of hope and generosity, the time in which the outrage for social injustice is felt the most. So I hope that our messages, the messages from the young people here, will arrive at the most sensible ears of northern Europe, those of the young people there (let us not forget here the young socialists massacred by the crazy Nazi guy in Norway). It is particularly important that, through any possible channel, more information about the situation in our countries be directed at the likely victims of disinformation, be they youths of Germany, Austria, the Netherlands etc,. We should take some initiative in this direction.
The story of the crisis
The story of this crisis is the story of an imperfect currency union. It is not yet clear to me which political processes led to the European Monetary Union (EMU). Unfortunately economists tend to neglect the analysis of the political processes, and indeed our aim is also to reform the way Economics is done and taught. From a rational point of view, the national leaders and their economic advisors certainly knew that the European Union was not a so-called optimal currency area. Various considerations possibly led to this imperfect union. France and Italy were not happy with the European Monetary System (EMS), the fixed exchange-rate that preceded the EMU: they though that a monetary union could be less German-dominated than the EMS. The German unification in 1989 and the fall of the iron curtain possibly accelerated the process (Germany has traditionally looked east, and the monetary unification was perhaps seen as a way to lock it west, but I cannot judge if this is a legend). Finally, through the common currency the elites in the periphery wanted to import the German renowned labour discipline. Be that as it may, the monetary union lacked the institutions that could make it work, in particular the significant federal budget with regional redistributive functions recommended by earlier unification plans (see also the prescient analysis by Kaldor and later by Godley). The union was designed in negatives, so to speak. To prevent national governments to take too advantage of lower interest rates, the Maastricht Treaty created the famous Maastricht fiscal constraints; the ECB was assigned a monetarist statute with the sole objective of controlling inflation (so that it inherited the Bundesbank function to keep German wages in check). The objective of full employment was assigned to national labour-market flexibility policies, that is to competitive internal devaluation strategies. No to a wider federal budget, no coordination of fiscal and monetary policies, no banks crisis resolution mechanism.
As we know, at the beginning the Euro seemed a success, particularly if judged from the point of view of Spain, Ireland and also Greece. Not much so for Portugal and Italy: the former country already had its demand-led boom in the years before the monetary unification and joined the currency with a negative current account, which explains its later stagnation. Portugal and Italy - but of course this partially also concerns the other southern countries - likely began to suffer from a loss of competitiveness due to more than one factor: an over-valued real exchange rate, the competition from the EU new entrants and from the emerging economies, the stagnation of domestic aggregate demand that depressed productivity growth In Portugal and Italy. As is well known, in Spain, Ireland and also Greece domestic demand was indeed sustained by a construction boom fed by foreign capital flows. The story has been usefully compared to that of the financial crises in the emerging economies: financial liberalisations and fixed exchange rates can easily lead to foreign capital flows that sustain a residential investment-led growth, ending later in a balance of payment crisis. This happens when foreign financial investors stop the refinancing of the peripheral foreign debt and begin to withdraw their investment (what is named “sudden stops and capital flows reversal”).
The peculiarities of the Eurozone (EZ) payment system, the famous and arcane TARGET 2 system, have impeded the eruption of the standard foreign debt crisis, with attendant debt restructuring and currency devaluation, which has been typical of the emerging economies. In this kind of crisis, typically the IMF intervened to assure that the indebted countries could continue to repay the interest and the principal of their foreign debt (so the IMF “saved” the banks of the north); normally the debt was renegotiated; fiscal austerity measures were imposed to obtain a current account surplus necessary to assure the future ability to serve and repay the debt (including that to the IMF); the currency devaluation relieved a bit the country in this effort. Notoriously, Argentina by refusing to repay 75% of her debt avoided the IMF austerity measures and, also helped by a buoyant price of her exported commodities, could manage a demand-led recovery. What has happened in Europe is that, through TARGET 2, the foreign debt of the peripheral countries has “changed hands”: from a liability towards private lenders (who withdrew their loans) it has become a liability towards the Eurosystem (the German conservative economist Werner Sinn has not been wrong in calling it a “stealth bail-out” of the periphery, although he missed to point out the German responsibility in this story. I also agree with him that this re-shuffling of liabilities has not made the German credits safer, contrary to the initial opinion by De Grauwe). In a sense TARGET2 helped to gain time, but this time has so far been wasted by the EZ governments. While no reforms of the institutional architecture of the EZ have been endeavoured, the EZ followed a wrong diagnosis of the crisis that, through austerity, made things much worse.
The peripheral governments have indeed basically backed the German interpretation of the crisis as caused only by the borrowers ( although the SPD also vaguely accuses the deregulation of the financial sector) and by the fiscal profligacy of the peripheral governments. This interpretation overlooks that the peripheral current account deficit financed by the northern capital flows sustained imports from core-Europe. Moreover, it forgets that the fiscal crisis was the result, in Ireland and Spain, also of the bailout of private banks, while the Italian public debt was much older and Italy before 2008 violated the fiscal pact much less than Germany and France. While the Greek centre-right government might have relied too much on an endless cheap foreign support to its public debt, it should not be forgotten that Greece has also been a excellent market for German exports (and possibly still is for the German and French armaments). Be that as it may, lenders are as much responsible as borrowers. But core-Europe is responsible for the crisis in an even more important way: its neo-mercantilist behaviour. The financial liberalisation and the fall in the devaluation risk (the ‘convertibility risk’ as Draghi calls it) and the consequent indebtedness of the periphery have indeed been functional to this behaviour.
This is an old story, indeed. Since the early 1950s Germany took advantage of fixed exchange rates to pursue an export-led mode. The three institutional pillars of the German low-inflation model were
- a paternalistic State, both with regard to the general welfare of the working class (the famous Bismarkian social state) and to trade (the German government has clearly foreign trade and foreign investment policy as its top priority, as the resignation of one President of the Federal Republic reminded to us: he candidly confessed that Germany sent troops to Afghanistan for commercial reasons).
- an accommodating labour movement;
- the Bundesbank as the watchdog of German labour discipline.
Wage moderation, the relative compression of the domestic market and the other countries’ Keynesism made the model successful: it has guaranteed a high standard of living in a self-fulfilling model in which the pursuit of trade surpluses promoted domestic labour discipline. The model was reinforced at the inception of the Euro by the SPD-inspired labour reforms. Although the model assured relatively high wages, following Kalecki we can regard it as a way for capitalists to maximise the level of the “internal surplus” - that is of what remains to them of the social product after having paid wages - and get rid of it (or realize it in Marxian terms) in foreign markets.
Note the parallel here between the U.S. and the EZ crises. In both cases residential investment bubbles (and more in general autonomous consumption financed by consumer credit) within a currency union sustained aggregate consumption from a middle class otherwise impoverished by decades of real wages stagnation. The internal geography, so to speak, changed, but the logic is similar. What is different is, of course, that the U.S. as a complete Federal Union had the will and means to deal with the crisis through monetary and fiscal policies and by implementing bank crisis resolution mechanisms, while the EZ as an imperfect Union retreated back to nationalistic behaviours.
There is a lot of things we must imitate from Germany – and the German people should in no way be regarded here as an enemy. There is a ‘benign’ form of mercantilism (quotation here) that consists of a developmental state promoting welfare and productive capacity. This form of economic nationalism is not at odds per se with a domestic demand-led growth and international economic cooperation. But the German hyper-nationalistic economic model has always constituted a problem for the world economy, and it is basically incompatible with the working of the EZ. This has been defined as malevolent mercantilism (quotation here). The suggestion that all the EZ countries should imitate Germany is a zero-sum game: a suicidal competitive deflation strategy. As Soros summed up, Germany has to lead or to leave.
As I said, I believe that we should decide here a strategy of communication with the German new generations, the only ones that perhaps have not yet suffered for too long from the Build, FAZ, BuBa etc. brain washing. Our student organizations should ask their German twins to be invited in the German Universities to explain the dramatic situation in our countries and the importance of a collective responsibility to bring Europe away from this self-destruction. A specific open letter might be prepared in this meeting in this direction and addressed to the main German Youth organisations (including the SPD’s Jusos, LINKE, Grunen etc.) The rich and generous German progressive foundations might be asked to finance this initiative: one hundred delegations from PIIGS countries to visit one hundred German universities. Germany has to decide if she wants to lead a prosperous Europe or if she just wants a backyard of impoverished countries, possibly a pool of unemployed labour for her ageing population. We must be competent enough to explain the terms of the situation to our German fellows, and so it is important that the interaction with the critical economists continues. It is also important that the European dimension of the crisis is fully endorsed by the movements.
In view of the German neo-mercantilist behaviour, a debate about the causes of the EZ trade imbalances has developed: one thesis emphasizes the structural lack of southern competitiveness often attributed to an unsustainable wage dynamics; more plausibly, another thesis argues that the trade imbalances are mainly due to the combination of the repressed German domestic market and wage moderation, and of the residential-investment demand-led growth in some peripheral countries. This led to higher inflation in the latter and to their loss of competitiveness. In this view, real wages are not the cause of the higher inflation and real exchange rates losses, rather the service/non-tradable sector, protected from external competition, appears to be the cause. Spain seems the typical example (the PIIGS families, as the Anna Karenina unhappy families, are each miserable in her own way, so it is always difficult to generalise). This debate is important to focus on – also in view of some discussion that has taken place on the manifesto of the meeting (I particularly sympathize with the comments by Jorge Uxo). What Europe seems to need is not so much a structural change in the periphery, but rather a German-led aggregate demand growth. This would help to rebalance the EZ. Inspired by an analysis of the periphery problems as due to too rigid labour market institutions and too high real wages – again a wrong diagnosis of the crisis – the widespread labour market reforms and wage deflation have negatively affected consumption demand, thus aggravating the crisis.
All in all, the way Europe has dealt with the crisis has been too little and too late (to kick the can down the road, as it has often been said). But even worse: the austerity imposed on the EZ has made the crisis worse. It may well be said that at present austerity is the main cause of the crisis.
The policies
The main policies so far have been:
a) Bail out packages (ESFS; ESM): used to bail-out Greece, Ireland and Portugal. They have a basic problem: the troubled countries also put the money, so Italy and Spain “loaned” money to their smaller troubled fellows to save the German banks (note that Germany lends at very convenient rates, and borrows also at very profitable rates, the opposite is true for Spain and Italy). Anyway, Spain and Italy cannot save themselves in case they need to be bailed out (it would be a vicious circle, somebody drowning cannot help herself): so the only real money would be from Germany: too much even from this mighty country. To make things worse, the bailed-out countries have been imposed a counterproductive austerity that made the crisis and public finances worse. Presently, everybody is realizing that Greece will not able to redeem the official loans it received (used to save the French and German banks). OSI (Official Sector Involvement) is the new EZ-acronym.
b) The ECB intervention has been limited to the early summer 2011 when the central bank bought about €200bn of peripheral sovereign bonds, without any persistent effect on the sovereign spread. Only an unlimited guarantee can obtain this result.
c) The liquidity made available by the Eurosystem assured that the banking system in the periphery did not collapse in view of the capital flights to core-Europe. As said, the liabilities of the periphery towards the private core-European investors have been substituted by the “official” TARGET2 liabilities towards the Eurosystem. Since most of the capital flights consisted of previous investment in peripheral sovereign debt that foreign investors progressively refused to refinance (roll-over), banks used the liquidity to sustain their respective domestic sovereign debts (In Italy, for instance, the share of foreign-held public debt has fallen form 60 to 30 per cent. This does not mean, however, that the Italian foreign debt has fallen: private loans have just been substituted by TARGET2 loans). What all this produced is that fragile banks sustain fragile states, and fragile states back fragile banks. What we would instead need is an ECB support to sovereign debts and a bank resolution mechanism: a European bail out of banks and deposit insurance (measures that cannot be left to national governments). Both measures would not hit the core-countries tax-payers as far as the intervention of the ECB keeps the sovereign interest rates at bay. The results of the European summit held at the end of June 2012 have been disappointing in this regard: no European banking crisis resolution mechanism seems to be in view.
d) From Summer and Autumn 2011 also Italy and Spain were inflicted various austerity packages. Italy was imposed a change in government with the implicit promise of an ECB intervention that never materialised. In addition, in Spring 2012 the EU approved the six-pack and the fiscal compact directing the EZ countries to balance their budget and to reduce the sovereign debt/GDP ration at 60% by year 2020. The logic of the austerity policy is as follows, austerity leads to credibility, which leads to lower interest rates on sovereign bonds and thus to recovery.
As a mounting evidence is showing, this option simply does not work and will not work.
e) Following his famous August declaration (“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”) in Sept. 2012 Draghi launched his OMT plan [Outright Market Transactions is the way the ECB defines the open market operations (OMO); in the ECB’s jargon OMO means bank refinancing operations]: the ECB cold intervene in the secondary markets buying, in principle, an unlimited amount of sovereign bonds (the big bazooka, although restricted to up-to 3y bonds); the countries asking for assistance should, however, subscribe to an austerity memorandum with the EU surrendering their national fiscal sovereignty. The idea of OMT is that lower interest rates will render austerity a bit less tough, so that unsustainable social unrest (so-called “austerity fatigue”) can be avoided, credibility regained, and maybe - the trust of financial markets being restored - some growth will appear, etc. The ECB will not pre-commit a given interest rate (or a given level of the spreads), so as to be able to blackmail in any moment governments, and anyway the reduction should not be too much, with a view to avoiding moral hazard, that is the temptation of dodging the “structural reforms”, cuts in public spending and labour market reforms. So the OMT does not really break with austerity policies asking the peripheral countries to surrender further national sovereignty to Bruxelles.
As known, the mere announcement by Draghi of this measure determined a fall in the Spanish and Italian sovereign spreads of some 150 basic points. This made plain to the public that the interest rates are determined by the central bank and not by the market, unless the central bank does nothing. It also showed that it is not necessary for the central bank to intervene and buy: the deployment of the big bazooka is enough to intimidate the markets.
We should finally mention the blah blah going on in Bruxelles on a European Federal Budget, nothing very serious, some bland anti-cyclical fund, nothing to do with a real redistributive Federal Budget (in fact, the existing small EU budget has been cut!). Indeed when Germany thinks of a European fiscal policy, it is just proposing the assignment of a pro-austerity power on national sovereign budgets to a fiscal authority in Bruxelles.
Alternative policies
Alternative policies have also been proposed and discussed.
Eurobonds
In my opinion Eurobonds are not an ultimate solution since by putting all sovereign debts in the same pot, the “credibility” of the German sovereign debt would be negatively affected and the political support by Germany undermined. A pan-European sovereign central bank that guarantees a European sovereign debt is the necessary measure to avoid this result. But if the ECB provides this guarantee, do we still need the Eurobonds? Perhaps yes, if the change in the statute of the ECB is deemed to be accompanied by a centralization in Bruxelles of fiscal policies. But this should not be done along German lines, however. The old French proposal (not of shy Hollande, tough) of a stronger Eurogroup that should be transformed from an informal club into the institutional fiscal counterpart of the ECB would be a good compromise to avoid an EZ fiscal Kaiser (the Germans have always refused this change because a political body would be stronger than a technical body like the ECB).
An alternative proposal
My favourite proposal is of an ECB intervention to calm markets down (the big bazooka) conditioned by a fiscal rule; this should consist of the stabilisation of the public debt/GDP ratios (not their reduction). This will be consistent with deficit spending policies. I would call it an “expansionary conditionality” or “Keynesian conditionality”. The rationale is that the savings obtained from the reduction in the interest rates should be used not to reduce sovereign debt/GDP ratio, but to sustain aggregate demand; the larger fiscal revenues will help the stabilization of the ratio. This is the most practical, politically reasonable proposal I can think of.
In addition we need:
- a solution to the banking crisis and a separation of sovereign and bank crises (this would be easier if the European state intervention is backed by the central bank)
- a looser wage and inflation policy, so to let wages rise especially in core-Europe in order to sustain aggregate demand. To this scope we need the right institutions, first of all a cooperative ECB that tolerates a higher inflation target and stops for good being the watch-dog of German wages. Instead of destroying the Trade Unions, the EZ south needs strong TU and income policies, plus measures to modernise the non-tradable sector, the source of the core-periphery inflation gap.
Many other things we need to do, but I do not like endless shopping lists. Let us focus on the macroeconomic measures first.
There are at least two further, opposite alternatives to be briefly discussed, a Federal Europe and a Euro break-up.
A Federal Europe
Optimistic Europhiles are thinking of the crisis as an opportunity to create a Federal Europe. The US could be a good example for a working Federal State from the point of view of fiscal and monetary policies, although less for social policy. We may, of course, dream of a progressive Europe, with social fairness and full employment. Of course Treaties in this direction should be re-written (including the ridiculous EU “Constitution” that says that the ECB must be independent and pursue price stability first). A Federal Budget should progressively be created, perhaps along the lines of the McDougall report of 1977. But I suppose this is not for this generation. The Spanish experience with Catalonia shows how much even old and consolidated states are fragile once exposed to external shocks (the austerity has clearly generated the Catalan resentment against the rest of Spain – that is, by the way, a market for Catalonia, as the Italian Mezzogiorno is for the Italian north).
A Euro Break-up
I am not able to assess how dramatic this event could be, there are different opinions. What is sure is that there should be a preliminary European political agreement, and a lot of peaceful financial negotiation later. The EU must be saved. A German exit might be easier, but do not underestimate the governance problems of a Southern Euro. We must study this, and our governments should study it to have a card to play to deal with Germany. It is clear that Spain, Italy and the other smaller southern fellows cannot endure this situation any further. We must therefore accompany our “reasonable” pro-European proposals with the option that we might go “our way” (a Mercosur with preferential ties with Latino-America and North Africa?).
Our duties
We have a difficult future ahead. But our fathers and grandfathers also had a difficult future ahead. I thought I belonged to a lucky generation that did not suffer hunger and wars, and the same I expected for my sons. It is not anymore true (at least we have not wars, yet). I assumed to be living in a situation in which any single individual was cared by society. It is not true anymore: we see a cynical ruling class, that includes Rajoy and Monti, literally destroying the lives and hopes of entire generations, old and young people alike. But we must fight and resist. Our specific duty as students of Economics and critical economists is to put the European question at the centre. The current European leaders must decide if they want to save Europe or not. They are the anti-Europeans, not us. We must explain to our fellow citizens that austerity is a policy choice and not a compelling fate, that different policies that would save Europe and prosperity are feasible. You must talk also to your young core-European fellows. If I am sceptical about solidarity, youth is the time for solidarity and change. I am sure they will listen. To do this, we must also fight to defend the space for critical economic thought in our universities. The Italian students of LINK have in this regard launched a petition that they will explain. We must defend critical Economics so as to be better trained in view of the tremendous challenges we have ahead. Good luck to all of you, and thanks.
* I thank Jorge Uxo for preliminary comments and Giancarlo Bergamini for valuable help in improving the exposition.
PIGS in Madrid
By Sergio Cesaratto* (Cesaratto@unisi.it)
Dear students and colleagues, ladies and gentlemen, companeros y companeras (if I am allowed to say so), I wish first of all to thank the organisers and the supporters of this event. I believe this is a beautiful opportunity to work side by side with the young people who are fighting against the present state of things and the critical economists. This is not a conference against Europe, or of one part of Europe against the other. As people of “troubled Europe” we feel perhaps more concerned than the majority of our northern fellows. But I think that the message of this meeting should arrive especially at your young northern fellows not just asking for solidarity (a word that I personally look suspiciously at), but because the dismantlement of the social rights in our countries might be the premise to the reduction in their own. I believe that they would defend the idea of their countries being part of a peaceful and prosper continent, and be outraged by the idea of their countries as islands in the midst of deprivation and resentment. I also believe that youth is the time of hope and generosity, the time in which the outrage for social injustice is felt the most. So I hope that our messages, the messages from the young people here, will arrive at the most sensible ears of northern Europe, those of the young people there (let us not forget here the young socialists massacred by the crazy Nazi guy in Norway). It is particularly important that, through any possible channel, more information about the situation in our countries be directed at the likely victims of disinformation, be they youths of Germany, Austria, the Netherlands etc,. We should take some initiative in this direction.
The story of the crisis
The story of this crisis is the story of an imperfect currency union. It is not yet clear to me which political processes led to the European Monetary Union (EMU). Unfortunately economists tend to neglect the analysis of the political processes, and indeed our aim is also to reform the way Economics is done and taught. From a rational point of view, the national leaders and their economic advisors certainly knew that the European Union was not a so-called optimal currency area. Various considerations possibly led to this imperfect union. France and Italy were not happy with the European Monetary System (EMS), the fixed exchange-rate that preceded the EMU: they though that a monetary union could be less German-dominated than the EMS. The German unification in 1989 and the fall of the iron curtain possibly accelerated the process (Germany has traditionally looked east, and the monetary unification was perhaps seen as a way to lock it west, but I cannot judge if this is a legend). Finally, through the common currency the elites in the periphery wanted to import the German renowned labour discipline. Be that as it may, the monetary union lacked the institutions that could make it work, in particular the significant federal budget with regional redistributive functions recommended by earlier unification plans (see also the prescient analysis by Kaldor and later by Godley). The union was designed in negatives, so to speak. To prevent national governments to take too advantage of lower interest rates, the Maastricht Treaty created the famous Maastricht fiscal constraints; the ECB was assigned a monetarist statute with the sole objective of controlling inflation (so that it inherited the Bundesbank function to keep German wages in check). The objective of full employment was assigned to national labour-market flexibility policies, that is to competitive internal devaluation strategies. No to a wider federal budget, no coordination of fiscal and monetary policies, no banks crisis resolution mechanism.
As we know, at the beginning the Euro seemed a success, particularly if judged from the point of view of Spain, Ireland and also Greece. Not much so for Portugal and Italy: the former country already had its demand-led boom in the years before the monetary unification and joined the currency with a negative current account, which explains its later stagnation. Portugal and Italy - but of course this partially also concerns the other southern countries - likely began to suffer from a loss of competitiveness due to more than one factor: an over-valued real exchange rate, the competition from the EU new entrants and from the emerging economies, the stagnation of domestic aggregate demand that depressed productivity growth In Portugal and Italy. As is well known, in Spain, Ireland and also Greece domestic demand was indeed sustained by a construction boom fed by foreign capital flows. The story has been usefully compared to that of the financial crises in the emerging economies: financial liberalisations and fixed exchange rates can easily lead to foreign capital flows that sustain a residential investment-led growth, ending later in a balance of payment crisis. This happens when foreign financial investors stop the refinancing of the peripheral foreign debt and begin to withdraw their investment (what is named “sudden stops and capital flows reversal”).
The peculiarities of the Eurozone (EZ) payment system, the famous and arcane TARGET 2 system, have impeded the eruption of the standard foreign debt crisis, with attendant debt restructuring and currency devaluation, which has been typical of the emerging economies. In this kind of crisis, typically the IMF intervened to assure that the indebted countries could continue to repay the interest and the principal of their foreign debt (so the IMF “saved” the banks of the north); normally the debt was renegotiated; fiscal austerity measures were imposed to obtain a current account surplus necessary to assure the future ability to serve and repay the debt (including that to the IMF); the currency devaluation relieved a bit the country in this effort. Notoriously, Argentina by refusing to repay 75% of her debt avoided the IMF austerity measures and, also helped by a buoyant price of her exported commodities, could manage a demand-led recovery. What has happened in Europe is that, through TARGET 2, the foreign debt of the peripheral countries has “changed hands”: from a liability towards private lenders (who withdrew their loans) it has become a liability towards the Eurosystem (the German conservative economist Werner Sinn has not been wrong in calling it a “stealth bail-out” of the periphery, although he missed to point out the German responsibility in this story. I also agree with him that this re-shuffling of liabilities has not made the German credits safer, contrary to the initial opinion by De Grauwe). In a sense TARGET2 helped to gain time, but this time has so far been wasted by the EZ governments. While no reforms of the institutional architecture of the EZ have been endeavoured, the EZ followed a wrong diagnosis of the crisis that, through austerity, made things much worse.
The peripheral governments have indeed basically backed the German interpretation of the crisis as caused only by the borrowers ( although the SPD also vaguely accuses the deregulation of the financial sector) and by the fiscal profligacy of the peripheral governments. This interpretation overlooks that the peripheral current account deficit financed by the northern capital flows sustained imports from core-Europe. Moreover, it forgets that the fiscal crisis was the result, in Ireland and Spain, also of the bailout of private banks, while the Italian public debt was much older and Italy before 2008 violated the fiscal pact much less than Germany and France. While the Greek centre-right government might have relied too much on an endless cheap foreign support to its public debt, it should not be forgotten that Greece has also been a excellent market for German exports (and possibly still is for the German and French armaments). Be that as it may, lenders are as much responsible as borrowers. But core-Europe is responsible for the crisis in an even more important way: its neo-mercantilist behaviour. The financial liberalisation and the fall in the devaluation risk (the ‘convertibility risk’ as Draghi calls it) and the consequent indebtedness of the periphery have indeed been functional to this behaviour.
This is an old story, indeed. Since the early 1950s Germany took advantage of fixed exchange rates to pursue an export-led mode. The three institutional pillars of the German low-inflation model were
- a paternalistic State, both with regard to the general welfare of the working class (the famous Bismarkian social state) and to trade (the German government has clearly foreign trade and foreign investment policy as its top priority, as the resignation of one President of the Federal Republic reminded to us: he candidly confessed that Germany sent troops to Afghanistan for commercial reasons).
- an accommodating labour movement;
- the Bundesbank as the watchdog of German labour discipline.
Wage moderation, the relative compression of the domestic market and the other countries’ Keynesism made the model successful: it has guaranteed a high standard of living in a self-fulfilling model in which the pursuit of trade surpluses promoted domestic labour discipline. The model was reinforced at the inception of the Euro by the SPD-inspired labour reforms. Although the model assured relatively high wages, following Kalecki we can regard it as a way for capitalists to maximise the level of the “internal surplus” - that is of what remains to them of the social product after having paid wages - and get rid of it (or realize it in Marxian terms) in foreign markets.
Note the parallel here between the U.S. and the EZ crises. In both cases residential investment bubbles (and more in general autonomous consumption financed by consumer credit) within a currency union sustained aggregate consumption from a middle class otherwise impoverished by decades of real wages stagnation. The internal geography, so to speak, changed, but the logic is similar. What is different is, of course, that the U.S. as a complete Federal Union had the will and means to deal with the crisis through monetary and fiscal policies and by implementing bank crisis resolution mechanisms, while the EZ as an imperfect Union retreated back to nationalistic behaviours.
There is a lot of things we must imitate from Germany – and the German people should in no way be regarded here as an enemy. There is a ‘benign’ form of mercantilism (quotation here) that consists of a developmental state promoting welfare and productive capacity. This form of economic nationalism is not at odds per se with a domestic demand-led growth and international economic cooperation. But the German hyper-nationalistic economic model has always constituted a problem for the world economy, and it is basically incompatible with the working of the EZ. This has been defined as malevolent mercantilism (quotation here). The suggestion that all the EZ countries should imitate Germany is a zero-sum game: a suicidal competitive deflation strategy. As Soros summed up, Germany has to lead or to leave.
As I said, I believe that we should decide here a strategy of communication with the German new generations, the only ones that perhaps have not yet suffered for too long from the Build, FAZ, BuBa etc. brain washing. Our student organizations should ask their German twins to be invited in the German Universities to explain the dramatic situation in our countries and the importance of a collective responsibility to bring Europe away from this self-destruction. A specific open letter might be prepared in this meeting in this direction and addressed to the main German Youth organisations (including the SPD’s Jusos, LINKE, Grunen etc.) The rich and generous German progressive foundations might be asked to finance this initiative: one hundred delegations from PIIGS countries to visit one hundred German universities. Germany has to decide if she wants to lead a prosperous Europe or if she just wants a backyard of impoverished countries, possibly a pool of unemployed labour for her ageing population. We must be competent enough to explain the terms of the situation to our German fellows, and so it is important that the interaction with the critical economists continues. It is also important that the European dimension of the crisis is fully endorsed by the movements.
In view of the German neo-mercantilist behaviour, a debate about the causes of the EZ trade imbalances has developed: one thesis emphasizes the structural lack of southern competitiveness often attributed to an unsustainable wage dynamics; more plausibly, another thesis argues that the trade imbalances are mainly due to the combination of the repressed German domestic market and wage moderation, and of the residential-investment demand-led growth in some peripheral countries. This led to higher inflation in the latter and to their loss of competitiveness. In this view, real wages are not the cause of the higher inflation and real exchange rates losses, rather the service/non-tradable sector, protected from external competition, appears to be the cause. Spain seems the typical example (the PIIGS families, as the Anna Karenina unhappy families, are each miserable in her own way, so it is always difficult to generalise). This debate is important to focus on – also in view of some discussion that has taken place on the manifesto of the meeting (I particularly sympathize with the comments by Jorge Uxo). What Europe seems to need is not so much a structural change in the periphery, but rather a German-led aggregate demand growth. This would help to rebalance the EZ. Inspired by an analysis of the periphery problems as due to too rigid labour market institutions and too high real wages – again a wrong diagnosis of the crisis – the widespread labour market reforms and wage deflation have negatively affected consumption demand, thus aggravating the crisis.
All in all, the way Europe has dealt with the crisis has been too little and too late (to kick the can down the road, as it has often been said). But even worse: the austerity imposed on the EZ has made the crisis worse. It may well be said that at present austerity is the main cause of the crisis.
The policies
The main policies so far have been:
a) Bail out packages (ESFS; ESM): used to bail-out Greece, Ireland and Portugal. They have a basic problem: the troubled countries also put the money, so Italy and Spain “loaned” money to their smaller troubled fellows to save the German banks (note that Germany lends at very convenient rates, and borrows also at very profitable rates, the opposite is true for Spain and Italy). Anyway, Spain and Italy cannot save themselves in case they need to be bailed out (it would be a vicious circle, somebody drowning cannot help herself): so the only real money would be from Germany: too much even from this mighty country. To make things worse, the bailed-out countries have been imposed a counterproductive austerity that made the crisis and public finances worse. Presently, everybody is realizing that Greece will not able to redeem the official loans it received (used to save the French and German banks). OSI (Official Sector Involvement) is the new EZ-acronym.
b) The ECB intervention has been limited to the early summer 2011 when the central bank bought about €200bn of peripheral sovereign bonds, without any persistent effect on the sovereign spread. Only an unlimited guarantee can obtain this result.
c) The liquidity made available by the Eurosystem assured that the banking system in the periphery did not collapse in view of the capital flights to core-Europe. As said, the liabilities of the periphery towards the private core-European investors have been substituted by the “official” TARGET2 liabilities towards the Eurosystem. Since most of the capital flights consisted of previous investment in peripheral sovereign debt that foreign investors progressively refused to refinance (roll-over), banks used the liquidity to sustain their respective domestic sovereign debts (In Italy, for instance, the share of foreign-held public debt has fallen form 60 to 30 per cent. This does not mean, however, that the Italian foreign debt has fallen: private loans have just been substituted by TARGET2 loans). What all this produced is that fragile banks sustain fragile states, and fragile states back fragile banks. What we would instead need is an ECB support to sovereign debts and a bank resolution mechanism: a European bail out of banks and deposit insurance (measures that cannot be left to national governments). Both measures would not hit the core-countries tax-payers as far as the intervention of the ECB keeps the sovereign interest rates at bay. The results of the European summit held at the end of June 2012 have been disappointing in this regard: no European banking crisis resolution mechanism seems to be in view.
d) From Summer and Autumn 2011 also Italy and Spain were inflicted various austerity packages. Italy was imposed a change in government with the implicit promise of an ECB intervention that never materialised. In addition, in Spring 2012 the EU approved the six-pack and the fiscal compact directing the EZ countries to balance their budget and to reduce the sovereign debt/GDP ration at 60% by year 2020. The logic of the austerity policy is as follows, austerity leads to credibility, which leads to lower interest rates on sovereign bonds and thus to recovery.
As a mounting evidence is showing, this option simply does not work and will not work.
e) Following his famous August declaration (“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”) in Sept. 2012 Draghi launched his OMT plan [Outright Market Transactions is the way the ECB defines the open market operations (OMO); in the ECB’s jargon OMO means bank refinancing operations]: the ECB cold intervene in the secondary markets buying, in principle, an unlimited amount of sovereign bonds (the big bazooka, although restricted to up-to 3y bonds); the countries asking for assistance should, however, subscribe to an austerity memorandum with the EU surrendering their national fiscal sovereignty. The idea of OMT is that lower interest rates will render austerity a bit less tough, so that unsustainable social unrest (so-called “austerity fatigue”) can be avoided, credibility regained, and maybe - the trust of financial markets being restored - some growth will appear, etc. The ECB will not pre-commit a given interest rate (or a given level of the spreads), so as to be able to blackmail in any moment governments, and anyway the reduction should not be too much, with a view to avoiding moral hazard, that is the temptation of dodging the “structural reforms”, cuts in public spending and labour market reforms. So the OMT does not really break with austerity policies asking the peripheral countries to surrender further national sovereignty to Bruxelles.
As known, the mere announcement by Draghi of this measure determined a fall in the Spanish and Italian sovereign spreads of some 150 basic points. This made plain to the public that the interest rates are determined by the central bank and not by the market, unless the central bank does nothing. It also showed that it is not necessary for the central bank to intervene and buy: the deployment of the big bazooka is enough to intimidate the markets.
We should finally mention the blah blah going on in Bruxelles on a European Federal Budget, nothing very serious, some bland anti-cyclical fund, nothing to do with a real redistributive Federal Budget (in fact, the existing small EU budget has been cut!). Indeed when Germany thinks of a European fiscal policy, it is just proposing the assignment of a pro-austerity power on national sovereign budgets to a fiscal authority in Bruxelles.
Alternative policies
Alternative policies have also been proposed and discussed.
Eurobonds
In my opinion Eurobonds are not an ultimate solution since by putting all sovereign debts in the same pot, the “credibility” of the German sovereign debt would be negatively affected and the political support by Germany undermined. A pan-European sovereign central bank that guarantees a European sovereign debt is the necessary measure to avoid this result. But if the ECB provides this guarantee, do we still need the Eurobonds? Perhaps yes, if the change in the statute of the ECB is deemed to be accompanied by a centralization in Bruxelles of fiscal policies. But this should not be done along German lines, however. The old French proposal (not of shy Hollande, tough) of a stronger Eurogroup that should be transformed from an informal club into the institutional fiscal counterpart of the ECB would be a good compromise to avoid an EZ fiscal Kaiser (the Germans have always refused this change because a political body would be stronger than a technical body like the ECB).
An alternative proposal
My favourite proposal is of an ECB intervention to calm markets down (the big bazooka) conditioned by a fiscal rule; this should consist of the stabilisation of the public debt/GDP ratios (not their reduction). This will be consistent with deficit spending policies. I would call it an “expansionary conditionality” or “Keynesian conditionality”. The rationale is that the savings obtained from the reduction in the interest rates should be used not to reduce sovereign debt/GDP ratio, but to sustain aggregate demand; the larger fiscal revenues will help the stabilization of the ratio. This is the most practical, politically reasonable proposal I can think of.
In addition we need:
- a solution to the banking crisis and a separation of sovereign and bank crises (this would be easier if the European state intervention is backed by the central bank)
- a looser wage and inflation policy, so to let wages rise especially in core-Europe in order to sustain aggregate demand. To this scope we need the right institutions, first of all a cooperative ECB that tolerates a higher inflation target and stops for good being the watch-dog of German wages. Instead of destroying the Trade Unions, the EZ south needs strong TU and income policies, plus measures to modernise the non-tradable sector, the source of the core-periphery inflation gap.
Many other things we need to do, but I do not like endless shopping lists. Let us focus on the macroeconomic measures first.
There are at least two further, opposite alternatives to be briefly discussed, a Federal Europe and a Euro break-up.
A Federal Europe
Optimistic Europhiles are thinking of the crisis as an opportunity to create a Federal Europe. The US could be a good example for a working Federal State from the point of view of fiscal and monetary policies, although less for social policy. We may, of course, dream of a progressive Europe, with social fairness and full employment. Of course Treaties in this direction should be re-written (including the ridiculous EU “Constitution” that says that the ECB must be independent and pursue price stability first). A Federal Budget should progressively be created, perhaps along the lines of the McDougall report of 1977. But I suppose this is not for this generation. The Spanish experience with Catalonia shows how much even old and consolidated states are fragile once exposed to external shocks (the austerity has clearly generated the Catalan resentment against the rest of Spain – that is, by the way, a market for Catalonia, as the Italian Mezzogiorno is for the Italian north).
A Euro Break-up
I am not able to assess how dramatic this event could be, there are different opinions. What is sure is that there should be a preliminary European political agreement, and a lot of peaceful financial negotiation later. The EU must be saved. A German exit might be easier, but do not underestimate the governance problems of a Southern Euro. We must study this, and our governments should study it to have a card to play to deal with Germany. It is clear that Spain, Italy and the other smaller southern fellows cannot endure this situation any further. We must therefore accompany our “reasonable” pro-European proposals with the option that we might go “our way” (a Mercosur with preferential ties with Latino-America and North Africa?).
Our duties
We have a difficult future ahead. But our fathers and grandfathers also had a difficult future ahead. I thought I belonged to a lucky generation that did not suffer hunger and wars, and the same I expected for my sons. It is not anymore true (at least we have not wars, yet). I assumed to be living in a situation in which any single individual was cared by society. It is not true anymore: we see a cynical ruling class, that includes Rajoy and Monti, literally destroying the lives and hopes of entire generations, old and young people alike. But we must fight and resist. Our specific duty as students of Economics and critical economists is to put the European question at the centre. The current European leaders must decide if they want to save Europe or not. They are the anti-Europeans, not us. We must explain to our fellow citizens that austerity is a policy choice and not a compelling fate, that different policies that would save Europe and prosperity are feasible. You must talk also to your young core-European fellows. If I am sceptical about solidarity, youth is the time for solidarity and change. I am sure they will listen. To do this, we must also fight to defend the space for critical economic thought in our universities. The Italian students of LINK have in this regard launched a petition that they will explain. We must defend critical Economics so as to be better trained in view of the tremendous challenges we have ahead. Good luck to all of you, and thanks.
* I thank Jorge Uxo for preliminary comments and Giancarlo Bergamini for valuable help in improving the exposition.
Hi, I would like to know what Cesaratto thinks of the fact that the institution behind the Treaty of Maastricht (undeniably, the Bundesbank) was against the entrance in the Euro of one of the two countries that was going to be most damaged by German wage moderation (namely Italy, the other country was France, they were the only ones in Europe who could compete with Germany using small devaluations). There was a great article in Der Spiegel (by no means a left-wing journal) telling the fight between Juergen Stark and Kohl about Italy. Yes, Stark was not in the Bundesbank at that time, he was minister of Finance, but the Bundesbank was supporting him in this fight. After all, the 60% rule in Maastricht was destined to avoid the entrance of Italy. Thanks.
ReplyDeleteGood question. Likely France did not want to leave a dangerous competitor outside the EMU. Political reasosn might have influenced Kohl (as when he imposed upon the BuBa the parity between the esat and wes DM in 1989). But perhaps also part of the German industry did not wanted to leave a competitor outside. Had I some spare time, I would like to study the story of the EMU (was Germany reluctant to adhere? What moved the Italian and French leaders, ti importthe German discipline? etc.).
ReplyDeleteHi, thanks for answering. Here are my thoughts about the question. I believe the Euro was a French request, for fear of the unbalance in favor of the mark in Eastern Europe. There were talks before the German reunification, but it is clear that everything accelerated after it. The BuBa was totally opposed to it, just like it was in the 60s, 70s (there were already fail attempts at fixed exchange rates, bombarded by the BuBa) and the 80s. The BuBa IS THE MOST ANTIEUROPEAN INSTITUTION. And by the BuBa, I also mean Deutsche Bank. Now, Germany had to give up the DM and accept the Euro, in order to show some pretense of European commitment to France, because it was clear that they were going to conquer the whole East. The DM was already in circulation in most ex-Soviet countries. But the BuBa "put the price of the Euro", like Bellofiore said. The Treaty of Maastricht was written by the BuBa, which means the Deutsche Bank (not the whole German banking system, but only the very concentrated and internationalized portion of it). But Deutsche Bank knew that Italian banks are not bad. That's what they feared. Italian banks have reasonable good lending practice, didn't finance any bubble, and actually I'm not aware of a relevant German banking penetration in Italy during the Euro. So they fought with everything they had to keep Italy out of the Euro. They even put rules that would accomplish that: Italy had to "cook the books" in order to enter.
DeleteBut on the other hand, German manufacturers wanted Italy IN. We can abbreviate German manufacturers by "Volkswagen". Italy and France traditionally fought for markets with Germany by appealing to small devaluations. So Volkswagen wanted Italy in at any cost. And Kohl took their side.
In the end, with the entrance of more countries, the liberalization in Eastern Europe and bubbles in many countries, Deutsche Bank enjoyed a period of prosperity and expansion, but also French banks. And with the Euro, Volkswagen expanded significantly.
I'll put another reply, continuing with the discussion.
Continuing with the debate, I have one objection to your article. I've been saying this things for some years now. Relative costs do not explain imbalances in the EMU. There was no divergence nor convergence in relative costs. German wages AND productivity stagnated. The effects of relative competitiveness might have some (not much, but some) relevance for Italy, and some for France, but they are by far the smallest part of the story. As a matter of fact, both the IMF and the ECB produced studies that show that, when you also include Asian economies, German competitiveness FELL (in a sample of 34 countries), and even so they gained market share. The best thing about German exports is not their cost, but their specialization. And the density of their industrial complex, the Mittelstand, with the Sparkasse. That's the key to German success, not price competitiveness, because there is one country that you didn't mention and that (in my view) destroy that argument: China. Nobody can compete with China in price, but still German exports to China raised a lot, because it exports capital goods that China doesn't produce. Yes, Germany's deficit with China increased, but that was because China displaced all the exports of Southern European countries.
DeleteThat doesn't mean that I'm against increases in German wages. I'm in favor of them. But they will not solve the problem of relative costs, because there's no problem. The problem is structural competitiveness (and by that I mean what each country produces; Greece doesn't produce almost anything, and what it does produce is not much affected by wages). German imports demand will increase, but there are another 196 countries in the world that might benefit from this. The solution is a Marshall Plan and industrial policy. By "structural" I don't mean "labor market reforms", at all. They will be damaging, just like they were in Germany, and Latin America. It has to be articulated with a fiscal transfer scheme in order to have a "validating" demand.
My last point, turning again to the story of the BuBa and Volkswagen. I really think that BuBa and Deutsche Bank are no longer interested in keeping the Euro as it is. It's undeniable that in the last couple of years there has been a process of financial DISintegration in Europe. The Deutsche Bank now has a bubble to finance inside Germany. They are not interested in keeping Spain or Greece or anybody else in the Euro. The speech of Target 2 is actually damaging more the Euro (I agree with De Grauwe and Karl Whelan on this issue, not with Sinn). And they have the assistance of the BuBa and Schauble. Volkswagen, on the contrary, still wants the Euro in its present shape. And Merkel is on their side.
Thanks for your thoughtful comments.Yes, price competitiveness is only part - perhgaps a small part - of the story. The compression of the German domestic market is another. German structural competitiveness a third. I agree.
ReplyDeleteThough. A Marshall plan would be helpful but a pro-active industrial policy - a mantra for the left - ...well, nobody has the secret to have a successful one. You likely need a developmental ruling class, sort of that. And Greece etc do not have it. So Marshall plan would be a big subsidy to part of the periphery. It could however help to revitalize the animal spirits in Italy and perhaps Spain.
Finally, I do not agree with Whelan; also De Grauwe has practically ecanted his endorsment of Whalan. Part of Sinn is correct, as Ramanan (The case of concerted action) has repeatedly shown.